Over the next year, companies could wind up spending some serious dollars to determine the fair value of intangibles and business units.
Such valuations are required in FASB’s new merger rules, which require that goodwill and other intangibles be tested for impairment rather than regularly amortized.
The standards become effective for companies at the start of their fiscal year and the first step of the impairment test must be completed within the first six months of adoption.
FASB will provide further guidelines on the implementation during the standards’ final issuance in late July, but senior financial executives may want to budget for the hefty expenses ahead of time.
Why? Just ask John Steuart, CFO of Mypoints.com, who went through the old impairment test last year with the company’s acquisitions of CyberGold. “The impairment work that we did at MyPoints.com added 25 percent to my total annual budget for accounting fees,” he tells CFO.com.
The cost, he says, quickly adds up because the valuation work is only one part of the equation. The assessment also has to be signed off by outside auditors, who have high fees. There are also legal costs, outside accounting firm charges, and internal staff to compensate for their time on the project.
Those charging the high fees have their own explanations. Simply put, valuing intangibles such as brands is not simple because the process is inherently subjective. “In the intangible asset world, the ability to get readily available information of fair value is greatly diminished,” says Brian Heckler, national partner in KPMG’s transaction structuring services, who believes management will incur “significant additional costs to implement the standard.”
Of course, fees will vary. Alfred King, chairman of Valuation Research, says that a benchmark assessment would cost companies between $15,000 and $20,000 per reporting unit, “based on my understanding of the work required and how much we charge for comparable work not related to FASB.”
Jim Schnurr, senior partner in Deloitte & Touche’s M&A group, says the price is not so cut and dry. Rather, the cost for valuation services often depends on how complex the business or reporting unit is and how many different types of intangibles would need to be valued separately. “The larger the business unit that is being evaluated, the more it would cost,” he says.
What’s more, companies can have several reporting units to perform benchmark assessments, and ultimately impairment tests.
Moreover, Schnurr says the second step of the impairment test — if needed — would be a more costly analysis than in the first step, in which a company calculates the overall (or fair) value of the reporting unit. If the fair value of the unit is less than its book value of its assets minus its liabilities, there is impairment.
In the second step, companies determine the size of the impairment loss, which requires spreading the fair value of goodwill to each of the reporting unit’s assets and liabilities. FASB also requires that some identifiable intangible assets separate from goodwill, such as trademarks and customer lists, be tested for impairment like goodwill.
“If I have to do an allocation to each asset and liability, it could (cost) several hundred thousand dollars on a multi- billion (dollar) transaction,” says Schnurr.
However, some argue that the high fees may not last. Since the impairment test will be done on at least an annual basis, King says the second-year valuation costs should ease somewhat because the benchmark assessment will have already been completed.
For instance, if the reporting unit is doing well, then its fair value is likely increasing. That, in turn, reduces the chance for an impairment loss.
But, if the reporting unit is doing poorly and fair value drops sharply, the unit would likely have a loss. In both cases, a simple comparison of book value with the initial benchmark fair value would be a relatively quick process, King says.
But if the difference between fair and book value is too close to call, King adds, “you’re going to have to essentially do the same amount of work as the initial benchmark that will tell you, ‘yes, I have a loss’ or ‘no, I don’t have a loss.'” In those cases, companies may incur the same high costs.
Mypoints’s Steuart adds, however, that the costs incurred in a potential inquiry and required restatement by the Securities & Exchange Commission is enough for any CFO to fork over the dough to do it right the first time. Doing it right involves not only valuing the assets and hiring competent and reputable people, but also coming up with a methodology for valuation.
“It’s a big piece of work,” Steuart says of the impairment test. “It’s cumbersome to do.”
And just the act of determining what qualifies as an identifiable intangible asset will be a process. Some intangibles, like patents, already fit the definition. The final statement issuance is expected to have much more objective criteria for what qualifies.
“But that’s going to be hard in practice to know which side of the line it is. Is it an identifiable intangible or isn’t it?” wonders Norman Strauss, Ernst & Young’s director of accounting standards. “In terms of an intangible asset, if you’ve got a genius in the company (the CFO, for instance), in a sense that’s valuable, but should you assign a value to it?”